Can Liquidity Events Explain the Low-Short-Interest Puzzle? Implications from the Options Market

43 Pages Posted: 7 Dec 2005

See all articles by Jefferson Duarte

Jefferson Duarte

Rice University

Ronnie Sadka

Boston College - Carroll School of Management

Xiaoxia Lou

University of Delaware - Alfred Lerner College of Business and Economics

Date Written: January 27, 2006

Abstract

This paper argues that liquidity events in short selling, such as short squeezes, margin calls, and stock specialness, may be an important part of short-selling constraints. We gauge the importance of liquidity events by utilizing a market-based measure, which is the cost of using options to limit the potential losses of short selling. Our approach circumvents the typical endogeneity problem in directly estimating the magnitude of short-sale constraints. We show that the costs of insurance against liquidity events exceed the abnormal profits of short positions. Our results therefore suggest that liquidity events can impose substantial costs on short sellers, and may thus explain the low-short-interest puzzle.

Keywords: Short-sale constraints, Liquidity, Limits to arbitrage, Asset-pricing anomalies

JEL Classification: G12, G14

Suggested Citation

Duarte, Jefferson and Sadka, Ronnie and Lou, Xiaoxia, Can Liquidity Events Explain the Low-Short-Interest Puzzle? Implications from the Options Market (January 27, 2006). EFA 2006 Zurich Meetings, Available at SSRN: https://ssrn.com/abstract=868387 or http://dx.doi.org/10.2139/ssrn.868387

Jefferson Duarte (Contact Author)

Rice University ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713.3486137 (Phone)

Ronnie Sadka

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Xiaoxia Lou

University of Delaware - Alfred Lerner College of Business and Economics ( email )

419 Purnell Hall
Newark, DE 19716
United States

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